New to the Board? Understanding Your Responsibilities Begins with Corporate Law Basics

Our series on directors’ and officers’ duties begins with this post on some basic principles of Canadian corporate law, including fiduciary duty and the duty of care.

The basic duties of Canadian directors and officers are established by statutes that exist in each Canadian province and territory, as well as at the federal level, and are usually called the “Business Corporations Act” of the jurisdiction in question.

The business corporations act that applies to a particular director or officer is the act that governs their company (usually the act under which the company was incorporated).

The most significant corporate law duties include the duty to manage, the fiduciary duty and the duty of care.

Background: Corporate Law Statutes

In Canada, a business may be incorporated under federal or provincial legislation. Many businesses – particularly larger ones – are incorporated under the federal Canada Business Corporations Act (CBCA), but it is also common for businesses of all sizes to be incorporated under equivalent provincial legislation in Alberta, British Columbia, Ontario, Quebec or another province or territory. Because the name “Business Corporations Act” is used in most provinces and territories, we will refer to these statutes collectively as “the BCAs”.

Federal vs. provincial incorporation

For many purposes, it makes little difference whether a corporation is federally or provincially incorporated – the CBCA and most provincial BCAs are very similar. Moreover, incorporation under the laws of a particular province or territory does not hinder a corporation from operating in other provinces or territories, although there can be slightly more paperwork involved than would be the case for a CBCA corporation.

There are nevertheless a number of reasons that could lead some businesses to prefer one BCA over another. For example, federal incorporation is sometimes thought to be more “prestigious” and thus more befitting a large or expansion-minded corporation, especially if it deals internationally. In addition, there are a number of substantive differences among the BCAs that can sometimes influence the choice – one example being different requirements with respect to the number of Canadians (if any) that a board must include (see Directors and Officers in Canada for more).

Directors’ and officers’ duties

At the broadest level, each of the BCAs imposes the same duties on directors and officers, while offering similar defences and requirements for indemnification. The most significant duties are:

The duty to manage;

The fiduciary duty (duty of loyalty); and

The duty of care.

The Duty to Manage

The BCAs require the directors to manage, or supervise the management of, the corporation’s “business and affairs” – “business” essentially meaning its trade and “affairs” meaning its internal corporate affairs. In modern corporations, boards usually focus on strategic, high-level decisions, leaving day-to-day decisions to professional managers. Having said that, there are limits on the powers that the board may delegate – in particular, it cannot delegate its authority to:

Adopt, amend or repeal corporate by-laws;

Issue securities;

Declare dividends; or

Approve financial statements.

There is one major exception, however. The board may delegate any or all of its powers to one or more non-Board members (typically shareholders) under a unanimous shareholder agreement (“USA”) or by an equivalent means under the British Columbia BCA. As noted in Directors and Officers in Canada, the BCAs differ slightly with respect to which parties to a USA can assume the rights and responsibilities of directors. The key point, however, is that anyone who takes on the rights of directors under a BCA also takes on the directors’ duties. Thus, a USA is not a means of “avoiding” directors’ duties; it simply shifts some or all of them to a different group of people.

Compliance with the duty to manage is relatively straightforward if the right reporting protocols are in place with management and provided that the board conscientiously attends to its strategic planning and management oversight roles.

Fiduciary Duty (Duty of Loyalty)

Each of the BCAs creates a duty of loyalty, also known as the “fiduciary duty”. A fiduciary is someone who is under a legal obligation to act in the interests of someone else, without regard to his or her own interests.

In the case of corporate law, the “someone else” whose interests the director must promote is the corporation itself. In other words, your loyalty as a corporate director should be directed to the corporation as such, rather than to the shareholders, creditors, employees or any other specific stakeholder group. However, at the same time (within the constraints of the fundamental principle just mentioned), it is important that a corporation be equitable and fair in its treatment of various stakeholder groups. Understanding what this duty requires in a given situation can be a challenge, and the board may need to seek the guidance of outside advisors before acting.

In addition to the very general requirement to act honestly and in good faith, the fiduciary duty requires directors to do certain more specific things, including (among others):

Manage the corporation’s assets in its own interests;

Avoid conflicts of interest with the corporation (or disclose them in situations where the law considers disclosure an adequate response);

Not use their positions for personal benefit (beyond what is allowed by law with respect to reasonable compensation, etc.); and

Maintain the confidentiality of information they require by virtue of being directors.

Directors and Officers in Canada provides more detail about situations that raise fiduciary duty concerns, including the “appropriation of corporate opportunities” – a doctrine of Canadian law that restricts directors, and (importantly) even ex-directors, from taking personal advantage of opportunities that were originally offered to the corporation.

Duty of Care

All of Canada’s BCAs call on directors and officers to act with the care, skill and diligence of a reasonably prudent person. This duty – known as the “duty of care” – requires board members to be diligent in ensuring that their decisions are made on an informed and rational basis. This does not mean that the board’s decisions must be perfect, but it does mean that they should be based on informed deliberation.

A corollary of this is that, if one of its decisions is ever challenged, the board will need to be able to demonstrate that it acted with care, diligence and skill. Boards will therefore want to consider the type of record-keeping that best protects them and their organization. As already noted, no one is expecting that the board will make perfect decisions every time: under the “business judgment rule”, Canadian courts will usually defer to the board’s business decisions as long as they were well-informed and reasonable.

Many decisions of the board have to do with areas of special expertise in areas like accounting, law, engineering, property appraisal, etc. Although some board members may hold professional qualifications in their own right, it is not mandatory to do so, and you will normally be able to rely in good faith on any of the following:

Financial statements signed by a corporate officer or in an auditor’s report;

Any report by a professional person (such as a lawyer, appraiser or engineer) whose profession lends credibility to what is said in the report; and

Any report by an officer of the corporation on which it is reasonable in the circumstances to rely (this is found in some BCAs only – see Directors and Officers in Canada for more detail).

Depending on which BCA governs your company, there may be some qualifications to the above or, in some cases, some additional grounds for reliance.

Note, however, that while board members do not have to have a professional’s understanding of accounting, engineering, etc., they should nevertheless be (or become) reasonably familiar with areas of professional practice that are relevant to their corporation in order to be able to understand the professional reports that the corporation receives.

Other Key Points

Potential liability for certain improper resolutions

In addition to the general duty of compliance, the fiduciary duty and the duty of care, as a director you have a duty not to support certain types of resolutions that would cause the corporation to fall out of compliance with its governing BCA. Typical examples of such resolutions include those that:

Authorize director indemnification that is contrary to the governing BCA.

Directors who support such resolutions may be personally liable to repay any improper payments that are made as a consequence. As noted in Directors and Officers in Canada, the various BCAs differ somewhat with respect to the range of resolutions that can trigger this type of personal liability for directors.

Defences and Indemnities

The BCAs provide directors with a range of statutory defences to allegations that they have breached their duties. These defences are described in slightly different ways in the various BCAs, but are generally focused on two concepts: “good faith reliance” and “diligence”. There are also situations in which the corporation may indemnify directors for their costs and expenses in certain circumstances. Generally speaking, such indemnification is mandatory in cases where a director was not ultimately found at fault and permissible in certain other circumstances.

The availability of defences and indemnities can differ significantly among the various BCAs, as outlined in Directors and Officers in Canada.

Conclusion

The foregoing is a brief summary of some of the more significant duties and liabilities that directors need to be aware of. For a more detailed account, which considers certain other aspects of the BCAs as well as many other statutes, see our Directors and Officers in Canada publication as well as the upcoming posts in this series.

DISCLAIMER: This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal advice and must not be treated or relied on as such. Please read our full disclaimer at www.stikeman.com/legal-notice.